First Small Multi Family... Help please!

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First Small Multi Family... Help please!

Jake Denning
Flipper/Rehabber · Houston, TX · Member since 2019 · 42 posts · 20 votes
My partner and I are currently working on a triplex but I am having some difficulties justifying everything because of the SOW. The Triplex is in pretty rough shape, there are two units which are stacked (upstairs and downstairs) as well as a separate unit. The two stacked units currently one is a 3/2 and the other can be turned into a 3/2, the separate building would be a 1/1. When this property was built it was just a duplex but they converted one of the units into two which are now stacked and the foundation was not meant for all the weight so the slab is sinking into the ground. I got a bid from our contractor who we know knows his stuff and all in all we would have to spend about 155k to get everything updated, cosmetically, structurally and save the property. It is no small project for us anyways. Only one unit is being leased out right now and it is the 3/2 that is upstairs for $535/m which is severely under market, we estimate the market rent to be about $1050/m each 3/2 and $750 for the 1/1 but the rest have to be finished out to be rentable.

The place we are concerned with is how the property will appraise in the future so that we can get ALL our money back out and turn it into a BRRRR. It is in a blue-collar more rural area on the outskirts of Houston. There are not a ton of comparable properties for us or a future appraiser to look at. We would estimate to be all-in the purchase price of 80k and rehab of 155k to 235k when it is said and done plus our closing costs, maybe around 255k. The property would need to appraise for around 330k to get most of our money back and have very little money left in the deal at an 80% refi, Problem is that we don't have much in the way of comps to base it off of. There was a 4-plex that is listed for 320k but they had no appraisal and were just basing it off the rents.

If we had everything up to date and fully rented we would have approximately $2850 gross rents, not quite the 1% rule we would like, Does anyone know if an appraiser would take rents into consideration if there are not alot of comps for small-multi? Or what is your take on the deal?

The owner also offered to owner finance the deal for a $400/m pmt for 2 years but at a 3% interest rate and 5% prepayment penalty, and a 20k down payment. So I know we could cover our costs no problem, I guess I am having trouble foreseeing what will be the end of this once we are all in, as we will have rehab loans to repay and principal balance to finish paying at the end of the 2 years...

Thanks in advance to anyone who takes the time to read this one...

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Richie Thomas
Rental Property Investor · Sedona, AZ · Member since 2018 · 260 posts · 141 votes
6y

Hey @Jake Denning, I'm only an aspiring investor (not an actual one, yet).  So take what I say with a grain of salt.

The first thought that occurred to me is to double-triple-check that the property's conversion from a duplex to a triplex was approved by city or county inspectors, and recorded with the recorder's office.  If the foundation is literally sinking into the ground due to the weight of the upper unit, it seems to me like there's a greater-than-zero chance that some un-permitted work took place.  If so, any code violations become your problem once you purchase the property.  And that problem gets worse if you accidentally rent to a professional tenant.  One way these people can cause problems for landlords is by calling the building inspectors (see this guy's story for an example).  If the work wasn't done to code, you could end up paying repair costs, building code fines, and suffering loss of rental income, since some jurisdictions don't allow you to collect rent until the building's defects are cured.  The good news is that, if you find out before you purchase that the work wasn't up-to-code or wasn't recorded, you could opt to use this information as leverage to talk the seller down on price.

The other thing I thought of when reading your post was that an appraiser may want to see the new rent values stabilized before factoring them into the appraisal.  My understanding is that this means you need to achieve a certain percentage of occupancy for a certain length of time (i.e. 80% occupancy for at least a year, although those are just hypothetical numbers).  I believe this would normally apply to commercial properties, which in this case would mean those with 5 or more units.  But a 4-unit is right on the cusp of that.  And in an area with few comps like the one you described, my guess is there's more ambiguity (and possibly more leeway as well) in the valuation process.  If you want the property to be appraised according to its ability to produce income, they might decide to use their regular criteria for income-producing properties.  Hopefully the bank's appraiser would be cooperative and use whatever criteria will result in a higher loan amount (which seems like it would be a win-win for you and the bank).

Of course, that doesn't mean you won't ever get your cash out at the higher appraisal value, you just might have to wait awhile before you can refi for the maximum amount.  The good news is that, in the meantime, you can still charge those higher rent amounts and get your cash flow going.

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  • Wayde C Hall
    Real Estate Agent · Orlando, FL · Member since 2018 · 31 posts · 6 votes
    6y

    Interested to see where this goes..  I'm new and to me it looks like your work to start the project may be a little too big for the return most would accept with the only comparable available which hasn't closed yet.  How many days on market/price changes has it had, that might give you an insight?  I want to know what professionals have to say.  Definitely following this.

    0Reply
  • Richie Thomas
    Rental Property Investor · Sedona, AZ · Member since 2018 · 260 posts · 141 votes
    6y

    Hey @Jake Denning, I'm only an aspiring investor (not an actual one, yet).  So take what I say with a grain of salt.

    The first thought that occurred to me is to double-triple-check that the property's conversion from a duplex to a triplex was approved by city or county inspectors, and recorded with the recorder's office.  If the foundation is literally sinking into the ground due to the weight of the upper unit, it seems to me like there's a greater-than-zero chance that some un-permitted work took place.  If so, any code violations become your problem once you purchase the property.  And that problem gets worse if you accidentally rent to a professional tenant.  One way these people can cause problems for landlords is by calling the building inspectors (see this guy's story for an example).  If the work wasn't done to code, you could end up paying repair costs, building code fines, and suffering loss of rental income, since some jurisdictions don't allow you to collect rent until the building's defects are cured.  The good news is that, if you find out before you purchase that the work wasn't up-to-code or wasn't recorded, you could opt to use this information as leverage to talk the seller down on price.

    The other thing I thought of when reading your post was that an appraiser may want to see the new rent values stabilized before factoring them into the appraisal.  My understanding is that this means you need to achieve a certain percentage of occupancy for a certain length of time (i.e. 80% occupancy for at least a year, although those are just hypothetical numbers).  I believe this would normally apply to commercial properties, which in this case would mean those with 5 or more units.  But a 4-unit is right on the cusp of that.  And in an area with few comps like the one you described, my guess is there's more ambiguity (and possibly more leeway as well) in the valuation process.  If you want the property to be appraised according to its ability to produce income, they might decide to use their regular criteria for income-producing properties.  Hopefully the bank's appraiser would be cooperative and use whatever criteria will result in a higher loan amount (which seems like it would be a win-win for you and the bank).

    Of course, that doesn't mean you won't ever get your cash out at the higher appraisal value, you just might have to wait awhile before you can refi for the maximum amount.  The good news is that, in the meantime, you can still charge those higher rent amounts and get your cash flow going.

    1Reply
  • Jake Denning
    OP
    Flipper/Rehabber · Houston, TX · Member since 2019 · 42 posts · 20 votes
    6y

    Thanks @Richie Thomas that definitely makes a lot of sense and I have no clue why I have not gone in to check on any previous permitted work. Sometimes it seems as if we are too close to the problem we are blind to the obvious solutions.

    Cheers!

    0Reply
  • Richie Thomas
    Rental Property Investor · Sedona, AZ · Member since 2018 · 260 posts · 141 votes
    6y

    @Jake Denning happy to help, keep us posted!

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  • Jake Denning
    OP
    Flipper/Rehabber · Houston, TX · Member since 2019 · 42 posts · 20 votes
    6y

    @Richie Thomas

    Thinking through this after what you mentioned I think the owner is scared to sell it outright because he would be in hot water due to the condition and the tenants are likely not safe to what the county would expect. So, he is probably just trying to owner financing it so it would probably fly under the radar till the work got done, then the inspection wouldn't matter anymore because it would be code... That's the only motivation I can come up with for why he would want to owner finance, he doesn't need a lump some and who the hell wants 3% interest when he could easily command 8-10% for an owner finance deal... Fishy... 🐟

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  • Richie Thomas
    Rental Property Investor · Sedona, AZ · Member since 2018 · 260 posts · 141 votes
    6y

    If seller financing was their idea, the property may not even be eligible for a bank loan, due to the inspection and appraisal contingencies that come with conventional financing. And if one of the units is currently occupied, that could mean they're renting an uninhabitable unit to unsuspecting tenants. Obviously I'm speculating here, and you should double-check all of this with qualified professionals who have a fiduciary duty to act as your agent. But this sounds like one possible scenario, given the structural problems you mentioned. At the very least, I feel like the seller should not expect 8-10% financing when an owner-occupant with excellent credit could command 3.5% on an FHA loan for a habitable property.

    Come to think of it, that would also explain why the property is priced below-market so severely- they may be looking for tenants who don't have better options and who aren't going to call the city inspector's office.  Again, I'm speculating here and I don't want to get carried away.  But you may want to research this seller's background, and whether they've been involved in any legal action in the past (either as a plaintiff or as a defendant).  If you're entering into a long-term lender/lendee relationship with this person, you should know who you're getting into business with.  And you should definitely have the help of an experienced real estate attorney to dot your i's and cross your t's beforehand.

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  • Tim JacobPro Member
    Real Estate Agent · Baltimore, MD · Member since 2016 · 520 posts · 379 votes
    6y

    This project seems very risky to me.  I second confirming the legality of the additional unit.  It could certainly effect the refi amount and might be a deal breaker where it crashes and burns.  Anything structural would turn me away.  Dont know how much funding you can do out of pocket but assumung your main contractor can offer financing through green sky or an equivalent or much of it for larger subs like hvac through a 5 year payment plan.  The payments will be large.  Furthermore has a structural engineer inspected it?  

    Have any title issues come up?    

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  • Arn CenedellaPro Member
    Rental Property Investor · Greenville, SC · Member since 2008 · 786 posts · 1k+ votes
    6y

    @Jake Denning

    I think you should walk away from this deal.

    Why buy a headache on your first investment?

    Even if your estimates are accurate, property still won't even meet the 1% rule.

    It would be one thing if after all the work, rent was 1.25% to 1.5% of the total investment.

    Then it might be worth the risk.

    The other issue is the area does not sound "ripe" for future increases.

    Is it in an area in the path of progress? In an area that is gentrifying? In an area where "hipsters" and your professionals are moving in?

    I have several small multi properties that did not meet the 1% rule off the get go.

    But they are in excellent areas where values and rents are increasing.....they are in areas that have a "vibe" to them - places people want to live. In these cases, I sacrifice so,e cash flow in the beginning for excellent long term prospects.

    I don't know Houston at all but based on your description, I don't think this property is in a go to area.

    I would pass.

    [email protected]650-575-6114
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  • Jake Denning
    OP
    Flipper/Rehabber · Houston, TX · Member since 2019 · 42 posts · 20 votes
    6y
    Originally posted by @Tim Jacob:

    This project seems very risky to me.  I second confirming the legality of the additional unit.  It could certainly effect the refi amount and might be a deal breaker where it crashes and burns.  Anything structural would turn me away.  Dont know how much funding you can do out of pocket but assumung your main contractor can offer financing through green sky or an equivalent or much of it for larger subs like hvac through a 5 year payment plan.  The payments will be large.  Furthermore has a structural engineer inspected it?  

    Have any title issues come up?    

    Thanks Tim! It has not been inspected by a structural engineer as of yet, I wanted to just dig as much as I could before spending any money on further inspections/ due diligence. I am guessing if an inspector did make it out there they would shut that **** down immediatley, it seriously is unsafe for the upstairs tenants. 

    0Reply
  • Jake Denning
    OP
    Flipper/Rehabber · Houston, TX · Member since 2019 · 42 posts · 20 votes
    6y
    Originally posted by @Arn Cenedella:

    @Jake Denning

    I think you should walk away from this deal.

    Why buy a headache on your first investment?

    Even if your estimates are accurate, property still won't even meet the 1% rule.

    It would be one thing if after all the work, rent was 1.25% to 1.5% of the total investment.

    Then it might be worth the risk.

    The other issue is the area does not sound "ripe" for future increases.

    Is it in an area in the path of progress? In an area that is gentrifying? In an area where "hipsters" and your professionals are moving in?

    I have several small multi properties that did not meet the 1% rule off the get go.

    But they are in excellent areas where values and rents are increasing.....they are in areas that have a "vibe" to them - places people want to live. In these cases, I sacrifice so,e cash flow in the beginning for excellent long term prospects.

    I don't know Houston at all but based on your description, I don't think this property is in a go to area.

    I would pass.

     I think we are going to have to pass, we have a few SFRs that we have done but its always cosmetic updates and not structural, I think you are definitely right on all of this. Arn, one more thing, because of the condition of the property and how unsafe it is, (we are talking about temporary supports for the last 2 years of those supports we are talking 2x4's that are holding up the floor of the upstairs unit not attached to anything, that could just be kicked out). I feel bad for the unsuspecting tenants who probably have NO CLUE how dangerous it is for their family to be there, there are 3 kids under 10 that live up there with both parents who were super nice. Would you advise informing the tenants of the dangers? It just seems ****** that their floor could literally collapse at any moment putting them at some serious risk of injury or even death. Is it any of my business? 

    1Reply
  • Diane G.
    CA · Member since 2016 · 1k+ posts · 1k+ votes
    6y

    @Jake Denning

    Anytime I see the word “foundation”, I move on....

    0Reply
  • Arn CenedellaPro Member
    Rental Property Investor · Greenville, SC · Member since 2008 · 786 posts · 1k+ votes
    6y

    @Jake Denning

    While I appreciate your concern for the tenant, I would not approach the tenants.

    It's not really your place.

    I learned a long time ago not to insert myself in someone else's business, it never ends well.

    Just my opinion.

    [email protected]650-575-6114
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